Drowning In Underwater Stock Options

The market's downward slide is forcing employers to rethink their next moves on stock options.

“Help! I’m drowning,” employees holding underwater stock options may be crying.

At the same time, institutional shareholders are singing a song called, “Don’t dilute me, let them go,” meaning employee holders of stock options and the options themselves.

With the stock market’s downward slide, many employers are finding themselves caught in deep water on the issue of stock options. As companies’ stocks dive, the employees they retained and lured with options are waking up to the fact that the current price of the stock has sunk below the exercise price of their options. In current parlance, those options are “underwater.”

Such employees may find that competing companies may be more than ready to pull them out of the drink. The double-whammy of the declining stock market and a labor market holding firm at just 4 percent unemployment is thus forcing many companies to rethink their approaches to equity options just to keep up with the competition for key talent.

Some may, for instance, reprice their underwater options or cancel them and issue new ones. (Both moves involve accounting caveats under the Financial Accounting Standards Board’s Interpretation No. 44, “Accounting for Certain Transactions Involving Stock Compensation.”) Or they may swap restricted stock for their employees’ drowning options.

But some action seems crucial now, if employers want to hold on to their talented, option-holding workers. Some companies may choose to discipline employees by letting them wallow in their underwater options. But that’s a bad idea.

“A company should not use underwater options as a way of disciplining management,” says Marshall Scott, a senior consultant in Chicago, with William M. Mercer Inc., the big benefits-advice firm.

“If you think managers are doing a poor job, then fire them,” Scott says. To continue to allow them to hold underwater options “is death by a thousand cuts,” he adds.

At the same time, besides the tight labor market and the declining stock market, employers are being hexed by means of a third whammy (slang for a “supernatural spell for subduing an adversary,” says The American Heritage Dictionary of the English Language). That’s the loud protests of institutional shareholders, who are battling to gain control of the use of stock options. They also represent a possible source of resistance to repricing options to benefit employees.

When a stock plummets, shareholders may be upset “because nobody’s resetting their share price,” Scott says.

Which factor should weigh more heavily on the minds of senior financial executives as they ponder the use of stock options as a compensation tool: The demands of big shareholders or the need to compete in the tight labor market?

A Simple Answer

I’ve got a simple answer. While shareholders have a right to know what’s going on in terms of the issuance of options at the companies they’re investing in, maintaining a competitive workplace must be a higher priority—for the shareholders’ own good as much as that of management and employees.


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